SECURED TRANSACTIONS
I INTRODUCTION
A. OVERVIEW OF STATUTORY SCHEME
The hardest part of secured transactions is understanding how the major concepts fit together.
This general overview introduces you to the statutory scheme and terminology of Article 9, which governs secured transactions. Secured transactions questions generally involve credit transactions. Typically one party (the debtor ) buys something from another (the creditor or secured party ) but does not pay immediately. The creditor wants to be able to rely on something other than the debtor's promise to ensure payment. A security interest is that something. A security interest is a limited right in specific personal property (the collateral) of the debtor that allows the creditor to take the property if the debtor fails to fulfill the credit obligations. A security interest is effective between the parties when certain steps are taken to attach the interest. Once the interest attaches, as between the parties, if the debtor defaults, the creditor has some right to take the collateral to satisfy the obligation. However, attachment generally does not provide the creditor with rights against third parties who might also have an interest in the same collateral. To gain rights over such third parties, the creditor must take additional steps to perfect the security interest. Perfection basically serves as a form of notice that the creditor has a security interest the collateral, and because of this notice, the creditor has rights in the collateral superior to certain third parties who might also have an interest in the same collateral (there are rules of priority to determine whose rights are superior).
B. SCOPE OF ARTICLE 9
1. In General
Article 9, with the exceptions listed in C., below, applies to all kinds of contractual security interests in personal property and fixtures (i.e., personal property that is firmly affixed to real property; see IV.B.3.9.1), infra). [U.C.C. §9-109(a)(1)] A security interest is an interests in personal property or fixtures that secures payment or performance of an obligation. a. Sales of Receivables
Outright sales of accounts, chattel paper, payment intangibles, and promissory notes are also treated as security interests and are covered by Article 9. b. Consignment
In a typical consignment, the consignor (i.e., the owner of goods, such as a manufacturer or wholesaler) retains title to goods and delivers them to the consignee (e.g., a retailer) for sale to the public. If the goods are not sold, the consignee may return them to the consignor. In cases where a creditor of the consignee would have difficulty distinguishing inventory that a consignee is selling on consignment from inventory that the consignee actually owns, Article 9 considers the consignment to be a security interest and requires the consignor to comply with its provisions to give notice to the consignee’s creditors. A consignor must comply with Article 9 to protect its interest in consigned goods against creditors of the consignee if:
(i) The consigned goods are worth a total of $1,000 or more :
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(iii) She consignee is a person who: i. Deals in goods of that kind under a name other than the consignor's ; ii. Is not an auctioneer , and
C. EXCEPTIONS
Article 9 does not apply to certain transactions, including:
(i) Transactions governed by other federal state, or foreign laws;
(ii) Most transactions involving interests in or liens on land (except transactions involving
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(iii) Assignments of tort claims (other than commercial tort claims , i.e., claims filed by organizations or claims filed by individuals that arose out of the individuals' business and that do not involve personal injury), except with respect to proceeds of the tort claims and priority in those proceeds;
(iv) Assignments of deposit accounts in consumer transactions (i.e., transactions in which an individual creates a security interest in property bought or used for personal, family, or household purposes ), except with respect to consumer deposit accounts that are proceeds of collateral, and priorities in those proceeds;
(v) State statutory or common law liens (other than agricultural liens) given for services or materials , such as mechanics' liens, except with respect to priorities in the personal property covered by the liens; and
(vi) Assignments of claims for wages .
D. SECURITY INTERESTS
Security interests generally relate to financing. There are three major types of financing: consumer, business, and agricultural. Article 9 contains rules that apply generally to all three methods of financing and special rules that relate to each specific type.
1. Typical Security Interest
In a typical Article 9 security interest one party (the creditor ) gives another party (the debtor ) something of value in exchange for the debtor's giving the creditor an interest in the debtor's personal property or fixtures (the collateral ). The creditor's interest in the collateral is not a full ownership interests but rather is the right to keep or sell the collateral if the debtor defaults on his obligation to the creditor.
2. Purchase Money Security Interests
A purchase money security interest (“PMSI”) is a special type of security interest in goods that has priority over all other security interests in the same goods if certain requirements are met. A
PMSI arises when:
(i) A creditor sells the goods to the debtor on credit, retaining a security interest in the goods for all or part of the purchase price (creditor and seller are the same person); or
(ii) A creditor advances funds that are used by the debtor to purchase the goods (creditor and
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seller are different persons).
Examples :
1) Matt purchases a $1,000 stereo on credit from Radio Hut and signs a security agreement giving Radio Hut a security interest in the stereo. Radio has a PMSI in the stereo since in reality its credit enabled Matt to purchase the stereo,
2) Susan goes to Bank and asks Bank for $1,000 to purchase a stereo. Bank gives Susan the money, Susan signs a security agreement giving Bank a security interest in the stereo, and Susan purchases the stereo from Radio Hut using that $1,000. Bank has a PMSI in the stereo since it advanced the money that was used to purchase the stereo.
Note: A good rule of thumb is this: A PMSI exists if (i) credit was advanced or a loan was made for the purpose of enabling the debtor to acquire the collateral, and (ii) the credit or loan proceeds were actually used to acquire the collateral. The importance of whether a security interest is a PMSI will be discussed later.
E. COLLATERAL
As indicated above, collateral is the property subject to a security interest. Under Article 9, there are various types of collateral that may be divided into three broad classifications: tangible collateral or goods, intangible or semi-intangible collateral, and proceeds. It is important to know the collateral's type because certain rules (e.g., rules for how to perfect and priority rules) depend on the type of collateral involved.
1. Tangible Collateral or Goods
“Tangible" collateral or “goods" includes all things movable at the time the security interest attaches (including timber to be cut, unborn animals, and growing crops, but excluding money and intangibles) and fixtures. a. Types
There are four types of tangible collateral: 1) Consumer Goods 2) Farm Products 3) Inventory 4)
Equipment
2. Intangible or Semi-Intangible Collateral
There are eight types of intangible or semi-intangible collateral: a. Instruments
Instruments are pieces of paper that represent the right to be paid money . They include promissory noise drafts (e.g. checks), and certificates of deposit and are sometimes into negotiable and nonnegotiable instruments. b. Documents
Documents are pieces of paper that represent the right to receive goods . They include bills of lading and warehouse receipts, and are sometimes divided into negotiable and non-negotiable documents.
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c. Chattel Paper
Chattel paper is a record or records evidencing both (i) a monetary obligation and (ii) a security interest in or a lease of specific goods, excluding the charter of vessels. A “ record " is information that is stored in either a tangible medium (e.g., written on paper) or an intangible medium (e.g., electronically stored) and retrievable in perceivable form. Chattel paper that is stored in an electronic medium is also called “ electronic chattel paper
” and chattel paper that is stored in a tangible medium is also called “ tangible chattel paper
.” d. Accounts
An account is any right to payment for good, services, real property, use of a credit, or lottery winnings that is not evidenced by an instrument or chattel paper (e.g. the money owed to a doctor after she sees a patient). e. Deposit Accounts
Deposit accounts are accounts maintained with a bank, such as savings or passbook accounts.
[U.C.C. §9-102(a)(29)] Recall that Article 9 only applies to nonconsumer deposit accounts and deposit accounts that are claimed as proceeds of other collateral f. Investment Property
Investment property includes items such as stocks' bonds, mutual funds, and brokerage accounts. g. Commercial Tort Claims
Tort claims that are filed by organizations (e.g., partnerships and corporations) are commercial tort claims. h. General Intangibles
General intangibles include any intangible not coming within the scope of the definitions of the other types of intangibles--e.g., software, patent and trademark rights, copyrights, and goodwill.
[U.C.C. ~9-102(a)(42)] A general intangible in which the principal obligation of one of the parties is the payment of money is also called a payment intangible .
3. Proceeds
Proceeds include whatever is received upon the sale, leased exchange, license, collection, or other disposition of collateral or proceeds. [U.C.C. §9-102(a)(64)] Proceeds differ from the other types of collateral in that they constitute any collateral that has changed in form from a previous category. For instance, if a farmer borrows money from a creditor and gives the creditor a security interest in the wool from the farmer's sheep, the wool is collateral of the farm product type. If the farmer exchanges the wool for a tractor or money, the tractor or
II. CREATION (ATTACHMENT) OF SECURITY INTEREST
INTRODUCTION
Article 9 concerns the secured party's rights against both the debtor and third parties who may have an interest in the debtors' property. The former involves a process called attachment and the latter involves a process called perfection. This section covers attachment. A security interest is
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not enforceable (i.e., the creditor may not repossess the collateral) unless it has attached.
B. REQUISITES FOR ATTACHMENT
There are three requirements for attachment of a security interest: (i) the parties must have an agreement that the security interest attach; (ii) value must be given by the secured party; and (iii) the debtor must have rights in the collateral. [U.C.C. §9-203(b)]
1. Parties’ Agreement
The parties must agree to create the security interest (i.e., they must enter into a security agreement ). This agreement must be evidenced in one of the following ways: a. Authenticated Security Agreement
The parties security agreement may be evidenced by a record (i.e., written or electronically stored information; authenticated by the debtor that describes the collateral and, if the collateral is timber…. A record is authenticated if it is signed or marked electronically with the present intent to identify the authenticating person and adopt the agreement.
1) Description of Collateral
The description of the collateral in the authenticated security agreement is sufficient if it reasonably identifies the collateral. Description of the collateral may be specific
(e.g. by serial number or by identifying it as “the debtor’s tractor” if the debtor only has one tractor) or it may be by category, type
(e.g. “all of debtor’s equipment”), quantity, computational formula, or any other method in which the identity of the collateral is objectively determinable. However, a supergeneric description of collateral, such as “all the debtor’s assets” or “all the debtor’s personal property,” is not sufficient. b. Possession
The security agreement may be evidenced by the creditor's possession of the collateral.
1) Rights and Duties of Secured Party in Possession c. Control
If the collateral is a nonconsumer deposit account, electronic chattel paper, or investment property , the security agreement may be evidenced by control.
2. Value
Value must be given by the secured party (or on his behalf) before a security agreement will be effective to create a security interest. Any consideration sufficient to support a simple contract is value. There is no requirement that the consideration actually have been performed; it is sufficient if the secured party is under a binding obligation to perform.
3. Rights in Collateral
The debtor must have rights in the collateral to create a security interest. An ownership interest in or the right to obtain possession of the collateral qualifies as “rights in the collateral."
III. PERFECTION OF SECURITY INTEREST
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A. IN GENERAL
As noted above, attachment establishes the secured party's rights to the collateral vis-à-vis the debtor. However, other parties may also have rights in the collateral (e. g., subsequent purchasers of the collateral, unsecured creditors' and other secured creditors). To acquire the maximum priority in the collateral over most such third parties, it is not enough that the security interest has attached; the secured party must also “perfect.” There are five methods of perfection: (i) filing; (ii) taking possession of the collateral; (iii) control; (iv) automatic perfection; and (v) temporary perfection.
1. Timing of Perfection
A security interest is not enforceable against any party until it has attached to the collateral.
Thus, perfection of a security interest cannot be completed until it has attached. In some circumstances, however, a party may complete all of the other steps necessary for perfection
(e.g., filing) before the security interest has attached (e.g., where an after-acquired property clause is used). In such a case, the security interest will become perfected at the time that it attaches (i.e., as soon as the debtor obtains an interest in the collateral).
Example : On August 1 Charlie fills out a loan application from Bank to borrow $1,000 to buy a stereo and signs a security agreement giving Bank a security interest in the stereo. Bank tells
Charlie that it will take five days to process the loan, so if approved Charlie can pick up the money on August 6. On August 2, Bank files a financing statement covering the stereo that
Charlie will purchase. On August 6, Charlie obtains the money from Bank, On August 7, Charlie buys the stereo. Perfection occurs here on August 7 because that is when the security interest attached.
B. PERFECTION BY FILING
A security interest may be perfected by filing (either in writing or electronically) as to all kinds collateral except deposit accounts and money.
[U .C.C. §9-3101 9-312(b)]
Records to Be Filed (the Financing Statement)
The Code simply requires "notice" filing. It does not require that a copy or abstract of the security Agreement be filed. Notice filing contemplates that once a third party discovers that a debtors' property is covered by a financing statements she will make further inquiry about the particular security agreement covering the property. "Notice" is given by the filing of a “financing statements'' which contains the following elements:
(i) The name and mailing address of the debtor ,
(ii) The name and mailing address of the secured party ;
(iii) An indication of the collateral covered by the financing statement and
2. Authenticated Security Agreement Itself May Be Filed
The authenticated security agreement itself may be filed as the financing statement if the parties so desire. If
3. Place of Filing
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a. General Rule--File Centrally
Generally, filing must be done centrally with the secretary of state.
4. Period for Which Filing Is Effective a. Original filing
A financing statement is effective for five years .
C. PERFECTION BY TAKING POSSESSION (PLEDGE)
A secured party may perfect a security interest in most types of collateral simply by taking possession of the collateral.
1. Collateral that Cannot Be Pledged
A security interest in accounts, deposit accounts, nonnegotiable documents, electronic chattel papers or general intangibles cannot be perfected by possessions even if tangibly represented; perfection by another means is required.
2. Time of Perfection
The time when perfection by possession occurs depends on whether the secured party has actual possession of the collateral or whether the collateral is in the hands of a bailee.
D. PERFECTION BY CONTROL
Security interests in investment property, nonconsumer deposit accounts, and electronic chattel paper may be perfected by “control.” (See E.B.1.c., supra, regarding methods for obtaining control.)
E. AUTOMATIC PERFECTION
In some transactions, the Code provides that the security interest is perfected simply by the attachment of the security interest, without taking any additional steps. This is referred to as
“automatic" perfection. Perfection is automatic in the following circumstances:
1. PMSI in Consumer Goods A PMSI in consumer goods is perfected as soon as it attaches .
[U.C.C. §9-309(1)] (Recall that a PMSI arises where the creditor (i) sells goods to the debtor on credit and reserves a security interest or (ii) advances the funds used to purchase goods and reserves a security.)
F. TEMPORARY PERFECTION
1. Twenty-Day Period for Proceeds
A security interest in proceeds from original collateral is continuously perfected for 20 days from the debtor's receipt of the proceeds. [U.C.C. §9-315(d] This security interest becomes unperfected on the 21st day after the debtor's receipt of the proceeds unless the statutory requirements are complied with. (See G., infra.) In many cases the requirements are automatically met.
IV. PRIORITIES
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A. INTRODUCTION
The heart of Article 9 is its allocation of rights or priorities between conflicting interests. In resolving a priority questions it is important to note the type of collateral involved and the types of parties involved. Conflicts can arise between (i) a secured party and another secured party, (ii) a secured party and a buyer or other transferee of the collateral, (iii) a secured party and a lien creditor (usually a trustee in bankruptcy) or a holder of a possessory lien, and (iv) a secured party and an Article 2 claimant .
B. SECURED PARTY VS. SECURED PARTY
1. Priority Between Unperfected Secured Parties
If both security interests are unperfected, the first to attach has priority. [U.C.C. 9-322(a)(3)]
This rule has little practical application because either secured party can easily get priority by perfecting.
2. Priority Between Unperfected and Perfected Secured Parties
Generally, a perfected security interest prevails over an unperfected security interest, even if perfected secured party takes her security interest with knowledge of the earlier unperfected security interest.
3. Priority Between Perfected Secured parties a. General Rule--First to File or Perfect
When there are conflicting perfected security interests in the same collateral, priority goes to whichever party was the first to either file or perfect -whichever is earlier-provided that there is no period thereafter when there is neither filing nor perfection. Thus, if both parties perfected by filing, the one who filed first has priority--even if perfection was not complete upon filing (see
111.A.1 supra). If one party perfected by filing and the other party perfected by some other method (e.g., taking possession) the party who filed will have priority if he filed before the other party perfected. And if neither party perfected by filing, the one who completed perfection first will have priority.
Example : On June 1, Debtor applies for a $10,000 loan from Bank A. Debtor signs a financing statement and a security agreement granting a security interest in Debtor's equipment. On June 2, after checking the files and finding no competing interests' Bank A files the financing statement.
On June 3, Debtor borrows $20,000 from Bank B, giving Bank B a security interest in the same equipment. Bank B loans the money and immediately files a financing statement covering the equipment. On June 10, Bank A loans Debtor $10,000. Bank A has priority to the equipment under the” first to file or perfect” rule since it was first to file, even though Bank B perfected its security interest before Bank A perfected its security interest. d. PMSI Superpriority
PMSIs enjoy a superpriority --they are superior to prior perfected security interests in the same goods if certain conditions (discussed below) are met. Rationale : The PMSI superpriority does not really harm the competing security interest since, but for the PMSI creditor, the debtor would not have the goods. Recall that a PMSI arises only where the seller sells goods to she debtor on
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credit and reserves a security interest in goods or where the creditor advances funds used by the debtor to purchase goods;
C. SECURED PARTY VS. BUYER OR OTHER TRANSFEREE
1. Unperfected Secured Party vs. Buyer a. General Rule--Buyer Prevails
A buyer of collateral (or a lessee of goods) takes free of a security interest covering the collateral if she both gives value and receives delivery of the collateral without knowledge of the security interest before it is perfected
. [U.C.C. §9-317(b) - (c)]
Example : On February 11 Manufacturer borrows money from Bank, giving a security interest in a piece of equipment as collateral. On February 2, Manufacturer makes a contract to sell the equipment to X, who pavs the full price. On February 3, Bank properly files a financing statement. On February 4, X takes delivery of the equipment. Bank prevails over X, because even though X paid before Bank perfected by filing, he did not take possession before that time.
D. SECURED PARTY VS. LIEN CREDITOR OR HOLDER OF POSSESSORY LIEN
1. Unperfected Secured Party vs. Lien Creditor
A lien creditor (i.e., a person who has acquired a lien on the collateral through judicial attachment levy, or the like) prevails over the holder of a security interest in collateral if the lien creditor becomes such before the security interest is perfected . [U.C.C. §9-317(a)]
2. Perfected Secured Party vs. Lien Creditor a. General Rule--Lien Subject to Prior Perfected Interest
A prior perfected security interest in the collateral has priority over a lien creditor's interest in the same collateral (see 1., supra] [UCC §9-317(a)(2)]
V. RIGHTS ON DEFAULT
A. DETERMINING WHEN DEFAULT HAS OCCURRED
Article 9 does not define the events that will trigger a default; rather, the security agreement will usually provide that upon certain events (e.g., failure to make timely payment, failure to keep the bilateral insured, unauthorized transfer of she collateral, etc.) the secured party may exercise default remedies. Default on an agricultural lien is determined by the lien statute.
B. RIGHT T0 TAKE POSSESSION OF AND SELL COLLATERAL
The right to take possession of and sell the collateral on default is the most important and most used of the rights on default.
1. Taking Possession a. Self-Help
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The secured party may take possession by self-help without judicial process if she can do so without a breach of the peace . [U.C.C. §9-609] Without removal, the secured party may also make equipment unusable and dispose of it on the debtor's property if she can do so without a breach of the peace. This latter right is directed toward the problem of taking possession of heavy, bulky equipment that is not easily movable.
1) “Breach of the Peace”
A repossession made over any protest by the debtor constitutes a “breach of the peace,” even though no violence or significant disturbance occurs. Constructive force or actions that contain implied threats are not peaceful. Thus, the secured party breaches the peace by carrying a weapon or dressing as a law enforcement officer. Breaking and entering is probably a breach of the peace, but simple trespass is not. Thus for example, a repossessor may hot wire a car sitting on a driveway, but not one sitting in a closed garage. b. Collection Rights of Secured Party
With non-goods collateral, such as accounts and instruments, upon default (and at any other time if so agreed), the secured party is entitled to notify the account debtor in an authenticated record to make payment to her, rather than to the debtor who is in default. Upon notifications the account debtor must pay the creditor rather than the debtor in default, unless the account debtor reasonably requests proof from the creditor that the assignment of collection rights has been made.
2. Sale
The secured party, after defaults, may sell, lease, or license collateral either in its condition when taken or after commercially reasonable preparation or processing. Disposition may be by either public (auction) or private sale, and by one or more contracts. a. Commercial Reasonableness
The general test as to validity of the sale is commercial reasonableness of the method, manner, time, place, and terms. The mere fact that a better price could have been…… b. Notice
Unless the collateral is perishable or threatens to decline rapidly in value or is of a kind ordinarily sold in a recognized market, reasonable notice that is authenticated by the secured party (i.e., the notice cannot be oral) must be given to the debtor and any sureties on the debt.
However, after default , the debtor or surety may, in an authenticated agreement, waive the right to notice of the sale. Except in the case of consumer goods
VI. JURISDICTIONAL RULES
A. WHICH STATE’S LAW GOVERNS PERFECTION?
The question of which state’s law governs the perfection of a security interest is especially important when a security interest is perfected by filing, because filing must occur in the state whose law governs.
Example : Bank wishes to file a financing statement to perfect its security interest in Debtor's equipment. Bank must file in the proper state . If Bank files in the wrong state, its security
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interest will not be perfected.
1. Parties' Agreement
Although the Code provides the rules described below for determining which states' law governs perfections, the parties may include a choice of law provision in their security agreement. Courts will generally uphold such a provision as long as the secured transaction bears a reasonable relationship to the chosen state.
2. General Rule--Law of State Where Debtor Is Located Governs Perfection
The law of the state where the debtor is located generally governs perfection of the security interest.
B. MOVEMENT OF DEBTOR OR COLLATERAL FROM ONE STATE TO ANOTHER
If the perfection of a security interest in collateral is governed by the law of a state where a person or collateral is located and that person or collateral moves to another state, the security interest generally remains temporarily perfected. If the secured party does not perfect in the new state before the temporary perfection period lapses, the security interest will become unperfected and thus lose its time of priority . The rules for temporary perfection in the new state are as follows.
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